Over the past few years, you may have found yourself ordering takeaway food from an app on your phone. You are not alone, from the first half of 2017 to the first half of 2019, the total food sales (gross merchandise value (“GMV”)) of listed food delivery platforms in the Western Hemisphere (Uber Eats, Just Eat, Takeaway.com, Delivery Hero, Grubhub) has grown from around US$6.5bn to around US$18bn[i]. In China, the scale is incredible, with Meituan Dianping’s GMV expected to grow from around US$24bn in the 2017 financial year (“FY”) to around US$55bn this year[ii], reaching an annualised run-rate by the end of the year of close to 10bn separate food orders. Further, Alibaba’s Ele.me, which is China’s #2 food delivery platform, will likely enable around US$30bn of transactions this year[iii].
The food delivery space has evolved significantly since the original pizza ‘delivery boys’. The first modern iteration emerged in the early 2000s as marketplace websites listed local takeaway options, allowing customers to make their selections digitally, and then processing orders and payments electronically on the restaurant’s behalf, taking a commission on each order. Once the customer placed an order, the restaurant then prepared and delivered the meal. For restaurants, being on the platform shifted the cost of acquiring customers from fixed (on Yellow Pages or doing pamphlet drops), to variable (i.e. a percentage of each order), and gave them exposure to a wide pool of customers. The website was significantly more convenient for customers than the previous option of finding a paper menu from the restaurant, calling the restaurant, battling with background noise in the restaurant to convey one’s food choices, and then providing credit card details to pay.
The first mover often established mindshare in a localised market, and then acquired the leading competitors in other cities and countries. It was very difficult for a competitor to dislodge the first mover, as the service provided was similar or even inferior due to fewer restaurant choices. The marketplace had strong bargaining power with restaurants as it provided order volume at high incremental margins to the restaurants. This allowed the marketplace to raise commission rates yearly. Strong sales growth outstripped marketing, selling and IT costs, resulting in strong and growing margins. Consequently, these companies became immensely profitable and cash generative over time. Prior to their recent forays into delivery, incumbents such as Just Eat in the UK[iv] (owner of Menulog in Australia), and Takeaway.com in the Netherlands[v], reported EBITDA margins in excess of approximately 50%, and Grubhub in the US reported EBITDA margins in excess of approximately 30%[vi].
The key restriction of the marketplace model was that the options available to consumers were limited to restaurants that already provided their own delivery service. Development of smartphone technology and the gig economy enabled the rise of new ‘delivery’ platforms such as Deliveroo, Uber Eats and DoorDash, the brands we know and see on the streets today. The new platforms performed the marketplace function, but also managed the meal delivery for a higher commission rate and were thus able to give consumers a wide and differentiated choice of restaurants compared to the incumbents. Other features such as better app interfaces, faster delivery times and the ability to track orders improved the end-user experience and increased the rate of adoption. An influx of venture capital allowed these businesses to disregard profitability and focus on gaining scale via consumer and delivery rider subsidies (e.g. $20 off your first order).
Initially, most incumbent marketplaces were reluctant to offer delivery, as they lacked the technological and logistical expertise (recruiting and operating a network of delivery riders is hard work), and as orders would likely be lossmaking for some time, they were wary of what would happen to their stock price if they pursued the delivery option. Within the last two years however, most have accepted the new reality and begrudgingly started to offer delivery. In most major markets (e.g. US, UK, Australia), it has likely been too little, too late, and the incumbents have seen the market fragment, order growth slow, and their profit pool erode as they lost their monopoly-like positions.
So far Meituan Dianping is the only delivery-led company (delivery makes up approximately 65% of orders) to have turned a modest profit helped by favourable market conditions such as a consolidated market, scale far beyond its Western peers (Chinese orders per capita is approximately 5x vs the US) and easing competitive pressures from competitor Ele.me. This raises questions around whether the model is sustainable in the West.
Our unit economics calculations in various markets suggest that food delivery could theoretically be profitable, provided markets consolidate and rationalise. On average, delivery platforms should make positive gross profits (revenue less delivery costs per order) managing the delivery for independent restaurants e.g. Deliveroo reported a gross margin of greater than 20% in FY17 and FY18[vii]. The bigger question is whether the marketing and promotional costs needed to acquire new customers and incentivise restaurants and riders will begin to fall. Just like the marketplace businesses before them, when the market matures and consolidates to one or two platforms, most of these costs should subside and delivery could yield modest profits. Meituan Dianping is a good example of this, moving from a lossmaking position to slightly profitable in recent quarters as the market consolidated and competitive pressures from Ele.me abated.
The question is then one of timing. Importantly, the large inflow of debt and equity capital into this space over the last two years will likely delay consolidation and point to continued investor enthusiasm in the industry (e.g. Amazon’s US$575mn[viii] investment in Deliveroo, Prosus’ takeover bid for Just Eat). It is unlikely that the incumbents’ market share and profitability pressures will ease in the short to medium term.
Furthermore, most investors and commentators are also ignoring several other key risks. First, food delivery companies, like other tech companies, are the subject of increased scrutiny from regulators for exploiting their market positions. There is a real risk that the unit economics get worse, as regulators force the platforms to cut the commissions they charge independent restaurants and pay riders more. Second, large restaurant chains (e.g. McDonalds) receive very favourable terms from the delivery platforms due to the boost they give to the frequency with which customers use the delivery app. This hurts the economics for the delivery players as they likely lose money on each McDonald’s order. Finally, the business model is untested through the cycle. We often find ourselves wondering if consumers would really be willing to pay $5 to have a $10 Big Mac meal delivered during a recession.
DISCLAIMER: This article has been prepared by Platinum Investment Management Limited ABN 25 063 565 006, AFSL 221935, trading as Platinum Asset Management (“Platinum”). This information is general in nature and does not take into account your specific needs or circumstances. You should consider your own financial position, objectives and requirements and seek professional financial advice before making any financial decisions. The commentary reflects Platinum’s views and beliefs at the time of preparation, which are subject to change without notice. No representations or warranties are made by Platinum as to their accuracy or reliability. To the extent permitted by law, no liability is accepted by Platinum for any loss or damage as a result of any reliance on this information.
[i] Figure 2, “Online Food Delivery: Darkest before the Dawn”, UBS Research, 11 December 2019
[ii] Bernstein research estimates
[iii] Grossed up (i.e. pre-deductions) assuming ele.me’s market share is approximately 35%. Exhibit 1, “Meituan vs Ele.me: Small difference in operating metrics, Big difference in profitability”, 9 December 2019
[iv] Just Eat FY16 annual report
[v] Takeaway.com FY16 annual report
[vi] Form 10-K filed with the SEC for Grubhub’s FY14
[vii] Deliveroo FY18 annual report
Disruption and Survival in the Consumer Market
Standing Out from the Crowd
Market Update - 12 December 2019
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